The Value of a CEO

The shenanigans surrounding Wal King's possible return to the board of Leighton Holdings after his resignation as CEO raises questions about how to value the contribution of a chief executive.

For nearly two decades, Wal King was hailed as one of Australia's most successful business executives. He was apparently well paid for his services. According to the Sydney Morning Herald this past week, he received some $150 million in cash over his 23 year tenure as chief executive of the company.

On the other side of the ledger, he gave a small Australian engineering group an international presence and a chance to expand dramatically. Work on hand has grown from $1.21 billion at the end of 1989-90 to $46 billion now. Sales have topped $20 billion after being just over $1.5 billion. Profits have grown from $20 million to an anticipated $650 million this year.

Investors buying shares at the beginning of the 1990s would have received a 28% annual return until the market peaked in October 2007. Since then, the share price has dropped 60% reducing the investment return but still leaving it at a creditable 18.5% a year over 20 years.

The burning question is how much of this is due to the CEO. From an investor's perspective, Wal King seemed to do a good job. The ASX 100 industrial stocks returned 13.8% over the same period to 2007 and 9.8% over the last 20 years, around half the Leighton return in each case.

A good many CEO remuneration packages are based on whether the share prices of the companies they lead have done better than the share prices of their peers. On that measure, King should have received more than the average CEO.

Some are now saying that King has left his successor a poisoned chalice. Far from being the saviour, he is actually the problem to be fixed. Unfinished business like the Victorian desalination plant are costing the company money.

This highlights a problem most companies have. They cannot claw back payments that have already been made if the results prove less fruitful than thought likely at first.

Requiring executives to take their pay in shares with minimum holding periods rather than cash is supposed to get them more focussed on sustainable longer term decision making.

Especially for investment bankers, there are moves to alter the terms of engagement to permit retrospective adjustments to their share allocations under some circumstances. Most corporates would find it had to do this if the CEO was operating to the instructions of the board to which he reports.

Higher profits are not always going to be reflected in higher share prices. Over the past 20 years, market price/earnings ratios have varied from as high as 22 at the end of 1994 to as low as 8 after the global credit crisis in 2008.

Global bond prices, inflation and market volatility will all have an effect on how much any level of earnings is worth. The valuation effects from a fall in bond yields from 11% to 6% have nothing to do with the CEO. Shareholders have shouldered the market risk accompanying such changes. A CEO who claims an additional reward under these circumstances is undeserving and purely opportunistic.

The converse is also true. If bond yields were to rise and price earnings ratios collapse, the CEO should not be blamed. That means, to be fair, any pay scheme should allow CEOs to obtain their greatest rewards when share prices are weakening if their operational and strategic targets are being met.

One of the roles of the CEO is to raise the investment attractiveness of the company he leads. The high achieving CEO should deliver a company whose share price is going to be higher than any other company with equivalent performance. This would be a vote of investor confidence and a sign of the intangible value that the CEO himself is adding to the corporation.

Ideally, the value premium generated by a CEO should rise over time as his capacity for superior decision making becomes evident. In the case of Leighton, an 18½ % a year profit increase over 20 years has delivered an 18½% a year investment return. Over the same period, as it happens, there has been no significant change in the market price/earnings ratio.

Wal King seems to have done what was required of him operationally but did not leave the company with such an enhanced reputation that the investment community had been prepared to pay more for a Wal King profit contribution 20 years later than at the beginning of his reign.

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